Discover the role of FHLMC securities in the mortgage market, their tax treatment, and comparisons to GNMA and FNMA risk profiles.
The Federal Home Loan Mortgage Corporation, commonly known as Freddie Mac, plays a vital role in the secondary mortgage market. Established in 1970, Freddie Mac’s primary function is to expand the secondary market for mortgages in the U.S. This is achieved by purchasing home mortgages from lenders, which are then pooled and sold as mortgage-backed securities to investors on the open market. This process provides liquidity, stability, and affordability to the mortgage market.
FHLMC issues mortgage-backed securities (MBS), which are known as participation certificates. These are created by pooling home loans purchased from financial institutions. The process helps these institutions lend more, thus fostering economic growth. Investors who purchase these securities receive principal and interest payments generated from the underlying mortgages.
The purchase of these securities is backed by the interest and principal repayments from these pooled loans, creating a reliable income stream for investors.
Freddie Mac’s involvement in the secondary mortgage market ensures that banks have enough capital to continue offering home loans. By purchasing and pooling loans, Freddie Mac helps stabilize the housing market by distributing risk and encouraging standardized underwriting practices. This process is crucial in maintaining a vibrant, competitive mortgage market.
The interest earned on FHLMC securities is subject to federal income tax but, unlike some other investments, is exempt from state and local taxes. This can make Freddie Mac securities an attractive option for tax-conscious investors, especially those in high-tax states.
When assessing the risk profile of FHLMC, it is essential to compare them with other government-sponsored enterprises like Government National Mortgage Association (GNMA or Ginnie Mae) and Federal National Mortgage Association (FNMA or Fannie Mae).
GNMA Securities: Ginnie Mae issues securities backed by the full faith and credit of the U.S. Treasury, making them less risky than Freddie Mac securities. They guarantee timely payments of principal and interest.
FNMA Securities: Similar to Freddie Mac, Fannie Mae operates without the full backing of the U.S. Treasury. This makes both Fannie Mae and Freddie Mac slightly riskier than Ginnie Mae, but they also potentially offer higher yields due to this increased risk.
Mortgage-Backed Securities (MBS): Investments secured by mortgages, which provide periodic payments consisting of interest and principal.
Secondary Mortgage Market: A marketplace where home loans and servicing rights are bought and sold between lenders and investors.
Agency Securities: Securities issued by government-affiliated organizations with an implicit government guarantee.
Liquidity: The ease with which an asset can be converted into cash without significantly affecting its market price.
The Federal Home Loan Mortgage Corporation, or Freddie Mac, is integral to the U.S. secondary mortgage market, providing liquidity and standardization. It offers mortgage-backed securities, which are taxed at the federal level but exempt from state and local taxes. When assessing risks, Freddie Mac securities lie between GNMA, which is backed by the U.S. government, and FNMA, another agency security. Understanding these distinctions is crucial for financial professionals, especially those preparing for the FINRA Series 7 exam.